Rick Perry’s claim of higher returns from Social Security alternatives

Question:“Governor Perry, what would you do to transform it [Social Security] from what you have described as a ‘Ponzi scheme?’”

Texas Gov. Rick Perry (R):“One of the other things that we talked about in the book, ‘Fed Up,’ was that states could open back up for their employees and/or their retirees -- we did that in the state of Texas back in the `80s. Those counties that participated in that have somewhere between 3 and 5 percent more going to their — or three to five times more going to their participants who opted out of Social Security.”

— Exchange on CNBC’s “Squawk Box,” Sept. 29, 2011

As Texas Gov. Perry continues to run away from some of the more pointed statements in his book, “Fed Up,” such as calling Social Security a “Ponzi Scheme” (see page 61), he has strived to emphasize his interest in finding solutions for the old-age retirement program. One example he has pointed to is the decision by three Texas counties — Galveston, Matagorda and Brazoria — to opt out of Social Security and start their own retirement plans.

In his book, Perry mentions the Texas counties’s move on the same page he labels Social Security a Ponzi scheme, but he doesn’t really explore it as an option for fixing Social Security. He simply mentions it as an example of where individuals would have done better on their own. “Employees in those private plans, having exercised their liberty at Washington’s sufferance, are reaping the benefits,” he asserted.

In his CNBC appearance, Perry was specific — that participants are getting “three to five times more” than people in Social Security. Is this correct? And does it make sense to even make this comparison?

The Facts

Social Security was created in response to the pervasive poverty during the Great Depression. It is designed to provide workers with a basic level of income in retirement, as well as disability pay and life insurance while they work. Just over 60 percent of the 54 million beneficiaries are retired workers; the rest are disabled workers, dependents or survivors. (For more information, read our popular primer on Social Security.)

In 1981, the three Texas counties decided to opt out of the Social Security system and begin their own plan, known as the Alternative Plan. (The federal government later prevented other counties from following them.) It was designed to also include a death benefit, survivors’ insurance and a disability benefit.

Between the employee and employer, Social Security takes about 12.4 percent in payroll taxes; the amount is slightly higher in Galveston County. Social Security is a pay-as-you-go system, meaning that current employees pay for the benefits of retirees, and that has put strain on the system as fewer and fewer workers have to support more retirees. The Alternative Plan, by contrast, operates much more like a defined contribution system — i.e., like a 401(k) plan — so the more you contribute, the higher your savings will be.

There are advantages and disadvantages to both plans, but we don’t think they are directly comparable. Social Security was designed to provide an income floor, not investment income. That’s why it is indexed to inflation, which the Alternative Plan is not. (Some portion of a person’s lump sum in the Alternative Plan can be converted into an annuity, providing a steady stream of non-inflation-adjusted income.) Like a 401(k) plan, a person owns the assets in the Alternative Plan, whereas no such ownership exists in Social Security — just a government promise of a continued benefit.

The most detailed study of the Alternative Plan, by the General Accounting Office in 1999, suggested that lower-income workers would fare worse under the Alternative Plan than under Social Security. A similar conclusion was reached by another 1999 report by the Social Security Administration. Those are pretty old reports, and a 1995 study by the National Center for Policy Analysis indicated that lower-income workers are not at a disadvantage. Still, Social Security is designed with a progressive redistribution toward lower earners.

With ownership comes more opportunities for mistakes. Some county workers blew all their savings when they got it as a lump sum. The Texas Tribune recently reported that Ray Holbrook, the former Galveston County judge who led the campaign to quit Social Security, rued the fact that when he retired 15 years ago, he decided to get an annuity that lasted only 10 years. His account is now empty, though — ironically — he continues to get Social Security benefits because he made years of contributions into that system before the county dropped out.

In any case, what about Perry’s claim that the county workers get “three to five times” more than their Social Security counterparts? Mark Miner, Perry’s spokesman, said it was based on data in the 1995 report, which showed that workers making $17,000 a year would get 50 percent more per month than under Social Security and workers making $75,000 or more would nearly get triple their Social Security payment.

Okay, so that’s really one-half to three times better, rather than “three to five times.”

Still, one of the authors of the NCPA report is Holbrook, the advocate for the alternative plans, so you have to take his analysis with a grain of salt. Is there another way to look at this?

The Texas counties are guaranteed a return of at least 3.75 percent, so that would be the floor. An opinion article in the Wall Street Journal recently said the average has been about 5 percent.

The latest Social Security estimates show that there is quite a range between low- and high-wage earners. A single man born in 1955 with very low earnings would see a return of 4.16 percent; a high earner would see a return of 1.31 percent. A one-earner couple born in 1955 with very low earnings would see a return of 6.43 percent; such a couple with high earnings would see a return of 3.65 percent.

Though they are far from retirement, people born in later years, such as 1985, can expect even lower returns, such as 0.85 percent for a high-earner single male. In any case, high-wage earners probably would fare better under the Alternative Plan, perhaps even as much as five times better, as Perry asserted.

A side note: Perry casts these plans as a possible alternative to Social Security, but the up-front transition costs would be extraordinary. The government would need to keep funding Social Security for older workers while putting virtually every cent aside in new accounts for younger workers. We are talking at least $1 trillion — or probably more — in up-front costs.

The Pinocchio Test

Depending on how you do the math, Perry’s assertion of “a return” three to five times greater in the Texas county plans could be technically correct, especially for wealthier workers.

But he’s comparing apples and oranges. Social Security was never intended to provide a rate of return, but an income floor, especially for low-income workers. And until Perry can explain how he might pay for the transition to these types of accounts, he shouldn’t really offer them as an alternative.